Supreme Court Ruling a Win for Businesses : Payout in Some Mergers Is Judged a Capital Gain

The Supreme Court on Wednesday limited the federal tax bite on some business mergers, handing a victory to investors and business owners.

In an 8-1 ruling, the justices said a cash payment in some transactions--commonly known as a “boot”--should be taxed as a capital gain rather than a dividend taxed as ordinary income.

The capital gain tax rate generally is lower, although the tax reform bill enacted in 1986 largely eliminated the different tax rates for capital gains and ordinary income.

Distinction Still Matters

The court said the distinction between tax rates still applies to a significant degree.

For example, it said, taxpayers may deduct capital losses to the full extent of their capital gains but they only are allowed to offset up to $3,000 of ordinary income with capital losses and must carry over the rest.

Wednesday’s case stems from the acquisition of a small West Virginia company by a corporation traded on the New York Stock Exchange.

The smaller company, Basin Surveys Inc., was owned by Donald E. Clark of Buckhannon, W. Va. Basin Surveys provides radiation, nuclear and electronic open-hole logging services to the petroleum industry.

Clark sold the business in 1979 to N. L. Industries in New Jersey, which produces petroleum equipment, chemicals and metals.

Saved Almost $1 Million

N. L. Industries gave Clark 300,000 shares of its stock and $3.25 million to acquire Basin Surveys. The cash payment is characterized as a “boot” in such deals.

The U.S. 4th Circuit Court of Appeals ruled in favor of Clark in 1987, sparing him from paying $972,505 in tax.

The Supreme Court Wednesday agreed with the appeals court that under federal law, because Clark surrendered more than 20% of his interest in N. L. Industries, he was entitled to capital gain treatment.

The 20% figure was based on N. L. Industries’ offer to Clark of two choices: He could receive 425,000 shares of N. L. Industries stock or 300,000 shares plus $3.25 million in cash.

Transaction Called Stock Sale

By choosing the latter option, Clark, in effect, gave up more than 30% of his interest in N. L. Industries in return for the cash, the court said.

Justice John Paul Stevens, writing for the court Wednesday, said that under federal law a shareholder who relinquishes more than 20% of his corporate control and is less than a 50% shareholder after the transaction is entitled to have cash proceeds from the transaction treated as capital gains.

Stevens said: “The boot-for-stock exchange in this case may properly be characterized as a sale of stock. Significantly . . . there is little risk that the reorganization at issue was used as a ruse to distribute dividend.”

Justice Byron R. White dissented.

The case is Commissioner of Internal Revenue vs. Clark, 87-1168.